Latvia vs. Iceland once again: a comment to Krugman's blog

On average, bus drives faster than a bicycle. That does not mean, however, that a bus always moves faster. Bus has a higher potential speed, i.e., it will beat the bicycle in a long distance. However, if one selects a short distance that includes a bus station, bicycle could even win the race.

Similar story with countries. By arbitrarily choosing short intervals, one can convincingly argue that almost any country in the world is doing best / worst than any other. By selecting base 2007 Q4 = 100 and comparing GDP fall during the crisis, Krugman has argued that Iceland does better than Latvia "thanks to heterodox economic policies":

Data source: Eurostat

The problem with such sort of analysis is that it overemphasizes cyclical movements and ignores a potential growth. In 2007, Latvia was overheated much more than Iceland: European Commission estimated an output gap as huge as 15% of GDP while the respective figure for Iceland was between modest 2% as estimated by OECD and 4.5% estimated by the Ministry of Finance. When the crisis came, positive output gaps cancelled out and first from the top became first from the bottom. Link between policy and outcome seems to be rather vague here: I wonder whether any policy mix could avoid the "the-bigger-the-boom-the-deeper-the-bust" outcome.

If we choose a longer distance, however, bus wins the race.

Data source: Eurostat

The overheated engine cooled down and is ready for the next trip. Not as quick as during the 2004 – 2007 in order not to harm the engine, but still enough for steady income convergence to the old-EU level.